Sunday, March 31, 2013

Our April Fool's wish: someone in the inner circle of power would finally tell the truth.

In an unprecedented abandonment of his carefully scripted responses to Congressional questions, Federal Reserve Chairman Ben Bernanke unleashed what appeared to be a heart-felt and spontaneous disavowal of the financial and political systems of the United States.

Asked a question about the wealth effect, Bernanke paused and said, "The wealth effect. Ah, right." He then smiled faintly and shook his head. "You want to know about the wealth effect? Well, I'll be candid with you. This whole thing is a kleptocracy--the financial system, the political system, it's one big kleptocracy. That's the real wealth effect."

Seeming to find his footing, Bernanke continued with a passion that startled the audience. "You know, I told myself to just repeat the party line for another year so I could step down quietly and let Yellen or another of the toadies take over, but I realized that I can no longer stomach the lies, the obfuscation and the plundering."

"Yes, I have a plum position lined up at Goldman Sachs after my retirement. You know, give a few speeches and pocket a couple of million dollars, but I am tired of the dirtiness of all this money."

Leaning into the microphone, Bernanke asked, "Aren't you tired of the dirtiness of all the money you take? Aren't you tired of the lies we're all living?"

"I am supposed to be an expert in economics. So I'll tell you how the system works in very simple terms. It's no different from the late Roman Empire, actually. The trick is to get close to the seat of Imperial power, which in our country is the Federal government. You bribe those on the make--there's always an abundance of them--to grant you special privileges, subsidies, contracts or a monopoly. You skim a great fortune off this proximity to political and financial power, and then you take this fortune and buy a rentier income--you know, thousands of rental homes, farmland, buildings in Manhattan, tax-free municipal bonds, and so on."

"This is how we ended up with cartels running everything: national defense, healthcare, higher education, the financial sector. You--the elected nobility--enable this vast skimming operation in the name of democracy and capitalism. But we all know those are facades. Democracy is a fraud at the national level, but we're all too cowardly to confess it."

Taking a sip of water, Bernanke said, "Let me tell you a little secret about all our policies based on Keynesian principles. Paul Krugman and I put on witch doctor masks and we dance around a campfire waving dead chickens and chanting nonsense. That's Keynesianism."

"It's hopelessly flawed, a disaster, for one simple reason: the Keynesians think all investment is productive, when the truth is most investment is unproductive and has to be written off. But that isn't allowed to happen any more, because those close to power would lose."

"As a result, everything we do and say here in Washington and in New York is a travesty of a mockery of a sham, an endless parade of lies, half-truths and spin. President Bush, in his own homespun way, spoke the truth when he said, 'This sucker's going down.' He meant the kleptocracy, the whole fraud we're living to enrich ourselves and keep power. I have had enough, ladies and gentleman, and this is my last public appearance as an employee of the Federal Reserve."

Fed officials explained the chairman's spontaneous comments as "the unfortunate result of a mix-up in the chairman's medication," triggering speculation that Mr. Bernanke had stopped taking Ibogaine. Sudden bursts of truth-telling are one side-effect of withdrawal, according to those familiar with the psychotropic medication.

According to sources within the Federal Reserve and Treasury, those supporting Janet Yellen as the new chair of the Fed are battling another faction who believe it would better serve the interests of the economy to install a high-frequency trading machine at the helm of the Fed. "There is a growing sense that it's time to cut out the middleman, so to speak, and just let the HFT computers openly trade the Fed's accounts," said one unnamed source.

Alas, April Fools. Sadly, no one in power has the courage to tell the truth.

Wait a minute--one former insider is willing to tell the truth--David Stockman:

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Once the meal was consumed, events ran faster than either expected. The rear-guard contingent of pixies had orbited Alexia all through dinner, powdering her cascade of blond-alder hair and her green dress with the magic of physical romance; and when Ross blew out the candles and impulsively drew her tight for a kiss, her response was equally warm. As the pair moved from an awkward dining-table embrace to the freedom of Alexia's bed, the pixies celebrated their victory with such enthusiasm that poor Hanover abandoned his pillow in the kitchen to seek respite in the living room. Their difficult three-level job successfully completed, the pixies arose from the Green Street house and flitted to their next assignment, a couple with a nine year-old who wanted another baby most desperately. Whether it was the fairies' absence or some deeper turn of Fate, no one can know, but certain instabilities which had lain undisturbed below the surface of the home's inhabitants began rumbling discontentedly. Half-truths, omissions and complicated plans may self-assemble into a seemingly durable structure, but when the tectonic tension finally snaps, the contraption can collapse as rapidly as a sand castle swept away by an onrushing tide. It was a small courtesy, Alexia reckoned, to notify Robin that she was home earlier than expected. And so while Ross enjoyed a post-passion shower, she drew the comforter round her and called her downstairs neighbor. Robin and Kylie were similarly sited in bed sans clothing, and it was fortunate Alexia could not see the effect her call had on Robin's youthful features, for his expression of consternation was very nearly comic-book in its exaggeration. His voice protectively flat, Robin clicked off the phone and whispered to Kylie in a stunned voice, "Alexia's been home since Friday night. Her friend's dog suddenly died, and the house-sitting was cancelled." Kylie sat up with a start. "Did she say anything about Ross?" "Not a word." "Do you think she kicked him out?" Frowning, Robin shook his head and said, "No, he would have called you, begging for a place to stay." "So the ruse is still working." "Apparently." "I have to tell him." Her urgent sense of duty overwhelming her modesty, Kylie tossed aside the comforter and clambered off the bed to reach the phone in her purse. "Wait," Robin cautioned. "Maybe it's better that he doesn't know." "And hope she doesn't guess first? No, he needs to know he's in Alexia's house." Brushing aside Robin's anxious protests, Kylie swept her long dark locks over her bare shoulder and clicked the auto-dial to Ross's number. Having just exited the shower, Ross heard the ring and rushed into the bedroom, hastily wrapping a towel round his midriff. Glancing at the incoming call's number, he drawled, "Hello, stranger." "I know this is going to be a shock," Alexia whispered harshly, "but you're in GreenDollGal's house. Robin hid it from you because there was no other place for you to stay, and he didn't expect her home for two weeks. But 'A.R.' is Alexia." Ross glanced nervously at the open door, and then relaxed as he heard Alexia showering in her bathroom. "That explains the dolls and shoes and movie posters." In a tone of urgent worry, Kylie asked, "How are you getting along with her?" "Strangely enough, just fine," Ross replied, and Kylie noted the guarded hush in his voice. "Are you alone? Can she hear you?" "No, she's showering," Ross reported. "Just be careful," Kylie murmured sternly. "You mean to hide my stuff so she doesn't suspect me?" "That too, but remember she takes guys to the sofa just to thank them for a favor—or for an envelope of cash." Ross paused in disbelief. "Do you really expect a lonely bachelor who hasn't touched a woman in years to find that appalling?" "Oh good golly," Kylie gasped. "She's already seduced you." "And I thought it was vice versa," Ross murmured, and then exhaled heavily. "Since it's revelation time, here's another sordid little secret. I hate to be the one to tell you, but your pal Robin was thanking somebody last night, and he seemed very, very grateful." "I know," Kylie replied in a small voice. "That's awfully broadminded of you." In a barely audible tone Kylie said, "No, that was me." "I see," Ross huffed. "So instead of joining me for dinner, you let yourself be lured into his lair." "I'm sorry I didn't call you, but one thing led to another." "You could say the same thing happened up here," he replied. "Great Jupiter, what a pickle." In a voice tinged with frustration Kylie asked, "Why didn't you tell me she came home early?" "There was no point in worrying you," Ross replied, though the truth was less admirable: he'd been so enamored of A.R. that it hadn't occurred to him to notify his neighbor. "If she hasn't tossed you out yet, then there's no reason you can't stay put until you find a new place," Kylie said. Unable to say that he'd already found where he wanted to live, Ross sighed, "Thank you for the vote of confidence," and rung off in a chaotic confusion of emotions: shock joined fear of discovery and then bounced off the jagged edge of jealousy of Alexia's sofa clients and an unpretty urge to flee before tripping on a messy bundle of lust and romantic hope.

NEW VIDEO/PODCAST: PEAK JOBS--CHS and Gordon Long discuss the future of work and employment:

I will be attending (not as a speaker) Mish Shedlock's Wine Country ConferenceInvestment Ideas for Unconventional Times on Friday, April 5 in Sonoma, California.$1,000 of the $1,400 fee goes to charity. The conference features an All-Star lineup of independent financial analysts: John Hussman, Michael Pettis, Jim Chanos, John Mauldin, Mish Shedlock and Chris Martenson. It's not often you get all this talent in one place for one day.

Thursday, March 28, 2013

The knowledge economy has important implications for both workers and organizations.

Setting aside that our economy is by and large organized to benefit a State-financial Elite and the technocrat Caste that serves them, let's consider the two classes of worker in what Peter Drucker labeled the Knowledge Economy in his 1993 book Post-Capitalist Society.

At the risk of simplifying Drucker's nuanced account, here is a precis:

The Marxist class division of labor vs. capitalist/management no longer adequately describes the new economy, as knowledge workers own "the means of production" which is first and foremost knowledge. Corporations and government offer an organization within which workers can apply their knowledge (i.e. the means of production in a knowledge economy).

Since the new economy is no longer characterized by capital vs. labor, it is a post-capitalist economy.

Knowledge workers are a minority of the workforce; the majority are service workers, either skilled or low-skilled.

Economist Robert B. Reich divides the workforce into similar categories: "symbolic analysts" (knowledge workers) and two classes of service workers: "routine producers" and "in-person servers."

Since the service workers own and leverage less capital (knowledge), their ability to create surplus value and thereby demand high wages is intrinsically lower than the knowledge workers.

This creates a structural tension, as society has to establish a way to maintain the wages of the service workers in an economy where the value and income they can generate by their labor is capped.

The other root cause of our present difficulties with the workforce might be termed a general lowering of employees' frustration tolerance.Many employees, particularly the younger ones, are increasingly reluctant to put up with factory conditions. Despite the significant improvements we've made in the physical environment of our plants. Because they are unfamiliar with the harsh economic facts of earlier years, they have little regard for the consequences if they take a day or two off.
For many, the traditional motivations of job security, money rewards, and opportunity for personal advancement are proving insufficient.Large numbers of those we hire find factory life so distasteful they quit after only brief exposure to it. The general increase in real wage levels in our economy has afforded more alternatives for satisfying economic needs.
There is also, again especially among the younger employees, a growing reluctance to accept a strict authoritarian shop discipline. This is not just a shop phenomenon, rather is a manifestation in our shops of a trend we see all about us among today's youth.
More money, time and effort than ever before must now be expended in recruiting and acclimatising our quality control programs have been put to severe tests; large numbers of employees remain unmoved by all attempts to motivate them; and order in the plants is being maintained with rising difficulty.

That this is not simply a bosses' problem was expressed by youthful Gary Bryner, President of the Lordstown local of the UAW (July 25, 1972):

There are symptoms of the alienated worker in our plant-- the absentee rate, as you said, has gone continually higher. Turnover rate is enormous. The use of alcohol and drugs is becoming a bigger and bigger problem. So has apathy within our union movement towards union leaders and towards the Government ... (The worker) has become alienated to the point where he casts off the leadership of his union, his Government... He is disassociated with the whole establishment.

Here's the key quote from this excellent historical essay:

Modern capitalism can, by and large, cope with the traditional type of economic problem, for instance those dealt with by Marx, it can continue to develop production. It is in difficulties, however, when confronted with a massive resistance to its values, priorities and whole pattern of authority.

In the traditional labor vs. capital framework, we expect the resistance to come from labor; in the knowledge economy, that resistance is arising from those who own and control the means of production, the knowledge workers themselves.

This has important implications for corporations, non-profit organizations and government alike. In Drucker's view, "Every organization has to build in organized abandonment of everything it does. Increasingly, organizations will have to plan abandonment rather than try to prolong the life of a successful policy, practice or product."

In other words, creative destruction is the necessary result of constant, purposeful innovation. Any organization which fails to do so will become obsolete. The same can be said of those providing the knowledge capital to the organizations, the knowledge workers.

One consequence that none dare speak is the absolute reduction of any functional need for layers of management, or anything resembling traditional management.The Internet is a tool for eliminating management, along with generally needless/useless meetings and the other sources of unproductive friction in modern corporate and government organizations.

Management exists to minimize the problems created by its own hiring mistakes.Valve says the secret of their management-free environment is hiring good people. That sounds right to me. We don't have any weak contributors in our start-up so we have never felt a need for management.
One of the interesting aspects of better global communications, better access to information, and better mobility is that collectively it reduces the risk of making hiring mistakes. When employers were limited to hiring people who lived nearby, and the only information at their disposal was lie-filled resumes, every growing company would necessarily absorb a lot of losers. But now that entrepreneurs can hire the best people from anywhere in the world, we have for the first time in human history the ability to create teams so capable they require no management structure. That's new.
I think the manager-free model only works for a business that has high margins and depends more on creating hits than cutting costs. The videogame business fits that model, as do many Internet businesses. And in both cases entrepreneurs can hire from anywhere in the world.
So here's my summary: Management only exists to compensate for its own poor hiring decisions. The Internet makes it easier to locate and then work with capable partners. Therefore, the need for management will shrink - at least for some types of businesses - because entrepreneurs have the tools to make fewer hiring mistakes in the first place.
Management won't entirely go away, but as technology makes it easier to form competent teams without at least one disruptive or worthless worker in the group, the need for management will continue to decline.

Even organizations based on rigid command hierarchies such as the U.S. military are finding that decentralized command decisions based on proximity to information flow, field intelligence and detailed knowledge of local assets trump sclerotic centralized command structures in getting demonstrable results.

If this is true in sprawling bureaucracies, it is certainly true in smaller organizations.

This is the economy that every worker has to understand if they want to navigate it to their own benefit. Every enterprise and organization that wants the most productive workers has to understand that their task is not "managing labor," it is offering workers of all levels opportunities to be effective and to contribute.

In my view, each worker is an enterprise, and the less time, energy and money wasted on management and friction, the more time and energy there will be for wealth creation or value creation, and as a result, more money available for wages.

NEW VIDEO/PODCAST: PEAK JOBS--CHS and Gordon Long discuss the future of work and employment:

I will be attending (not as a speaker) Mish Shedlock's Wine Country Conference Investment Ideas for Unconventional Times on Friday, April 5 in Sonoma, California. $1,000 of the $1,400 fee goes to charity. The conference features an All-Star lineup of independent financial analysts: John Hussman, Michael Pettis, Jim Chanos, John Mauldin, Mish Shedlock and Chris Martenson. It's not often you get all this talent in one place for one day.

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Before you start nitpicking the list: yes, there is only one of you, so the list is somewhat repetitive.

And yes, there are some downsides to working for yourself. For example:

1. There's no point in leaving a snippy note on the fridge to the sneaky co-worker who stole your bagel: oops, you ate it during coffee break #3 without noticing. Dang, accepting responsibility sucks.

2. When you launch a full-blown rant against your psycho, control-freak, demanding boss, you're doing so in front of a mirror. Sigh--it's just no longer fun blaming the boss.

3. Excuses don't fly too far with clients and customers.

4. Nobody cares when you show up or how productive you are except you.

5. Shouting "Take this job and shove it" isn't quite as satisfying.

All those stupid regulations you chafed under: gone. All those impossible demands that stressed you out: gone. All those shiftless, incompetent co-workers: gone. Time cards: gone. Staff meetings: gone. People to blame for your troubles: gone. Paycheck: gone.

Do you really miss anything but the last item? But really, wasn't that paycheck the chain that bound you to serfdom?

Here's the dirty little secret of the U.S. economy: you're already working for yourself now unless you're in the Armed Forces or a civilian equivalent. The clock is ticking on all those promises of pensions and benefits for life you think separate you from the self-employed entrepreneur. Maybe the promises pay out for a few more years, maybe even a decade, but they are impermanent for the simple reason that the promises made (and the nation's debts) far exceed the economy's ability to pay those promises and debts in dollars retaining today's purchasing power.

Either the promises will be broken/defaulted, or a $2,000/month pension will buy a loaf of bread and a gallon of gasoline. There is no other end-state other than default or inflate-away-the-debt/promises.

You already know how "valued" you are by your corporate/agency employer. All that rah-rah "team-building" stuff is nice for the younger employees who are still naive enough to believe the propaganda at face value, but once the layoffs start again (if they ever stopped), then all that rah-rah cheerleading loses its sparkle.

Many employees are waking up to find themselves in 1099 nation: no benefits, no tax withholding, no matching 401K, no status as an employee, just a contract and a 1099 statement at year end.

In a sense being self-employed simply means stripping away the artifice that somebody else is going to take care of you or give you "free money." Once we understand the promised security is bogus, self-employment doesn't feel so risky--it feels like embracing the risk that is hidden behind the flimsy facade of team-building, "guaranteed" pensions and all the rest of the unpayable promises.

The self-employed person generally trades "security" for job satisfaction. The compensation may be higher or lower, but it will likely be lower. The earnings will likely be more sporadic and uncertain.

But ironically, perhaps, the insecurity of self-employment can generate a far more resilient life and mindset. Instead of counting on Big Brother in one form or another to provide retirement, the self-employed person builds their own human, social and financial capital. Those who rely on Big Brother are terribly vulnerable should Big Brother fail to make good on on his extravagant promises to 310 million people.

Gaining power and control over your life doesn't come cheap. Does anything really worthwhile come cheap? Knowledge, tradecraft, experience, networks of trusted suppliers, expertise: none of them come easy or cheap. All must be gained the hard way.

No wonder self-employment is down. It's tough to scratch out a living as an entrepreneur. It can be wearisome, but never as wearisome as a job you loathe.

In August, 14.5 million people were self-employed, down 2.1 million from the most recent peak in December 2006, according to Bureau of Labor Statistics data.The number of "incorporated" self-employed workers — those who incorporate to gain legal protection and other benefits — began its decline in 2008. Last month, 5.1 million people were in this category, down 726,000 from August 2008.
Unincorporated self-employed — at 9.4 million last month — has changed little since last spring. It's hovering at its lowest level in 25 years, says BLS economist Steven Hipple.

Working for others is a good idea while you're building skills and networks. By all means, work for someone else while you're learning the ropes, and give them 150% value on the paycheck they hand you. Heck, if you find a decent employer, work part-time for them while you build your own income streams/career. You might even work part-time for several like-minded people and yourself on the side.

Interestingly, this survey found that the self-employed often see their work as helping society. How many employees feel that? I mention this as an example of the intangible benefits of working for yourself.

According to research by Economic Modeling Specialists International, the number of people who primarily work on their own has swelled by 1.3 million since 2001 to 10.6 million, a 14% increase.This rise is partially reflective of hard times, and many of the self-employed earn only modest livings in fields such as childcare and construction. However the shift to self-employment is likely to accelerate in the future, and into higher-paying professions, for reasons including the ubiquity of the Internet, which makes it easier for some types of business to use independent contractors, as well as the reluctance of large firms to hire full-time employees with benefits.

How can self-employment be falling and rising? It depends on how you count the self-employed. The Bureau of Labor Statistics (BLS) divides the self-employed into two categories, incorporated (about 5 million) and unincorporated (about 10 million). Incorporated self-employed people are often professionals such as doctors, accountants and attorneys who value the legal benefits of a corporation or LLC (limited liability company).

To further confuse things, the BLS counts the incorporated self-employed as "wage earners" because they draw paychecks from themselves. So right off the bat we find a confusion between 14.5 million (total BLS self-employed) and the 10 million (the unincorporated self-employed) reported by the BLS as self-employed.

The private research firm mentioned above clearly counted those getting 1099s as self-employed, even if they are contract workers laboring alongside employees, as is often the case in Corporate America. It appears there are about 7 million people in 1099 nation, hence the other total of self-employed you see in print, 22 million.

So the conventional self-employed may be declining while the involuntary self-employed (those getting a 1099 instead of a paycheck) is rising. Of course it's rising: the ObamaCare neutron bomb is about to go off, making employee benefits unaffordable to businesses large and small.

Right now the self-employed--an enormously diverse mix of everything from micro-sized eBay businesses netting a few thousand dollars a year to professional corporations--comprise about 10% of the workforce (14.5 million self-employed, a total employed workforce of about 142 million). Add in those now getting 1099s instead of paychecks (7 million) and perhaps 14% of the workforce is self-employed (or at least responsible for paying their own quarterly taxes and healthcare insurance--slick move, Corporate America!).

For reasons I will discuss tomorrow, this number is very likely to rise.

But why, you ask, is working for yourself so great? I'll tell you why. Where else will you find a boss who knows your foibles, flaws and strengths so well? Where will you find a more forgiving boss, one who really understands what makes you tick? What other employer will give you the day off to go fishing because you really need a break? What other employer is going to let you keep everything you earned for the enterprise? And best of all--where else can you be boss and not have to deal with employees?

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Tuesday, March 26, 2013

If we shed our fixation with the Fed and look at global supply and demand, we get a clearer understanding of the tailwinds driving the U.S. dollar higher.

I know this is as welcome in many circles as a flashbang tossed on the table in a swank dinner party, but the U.S. dollar is going a lot higher over the next few years. For a variety of reasons, many observers expect the dollar to decline against other currencies and gold, the one apples-to-apples measure of a currency's international purchasing power.

The tailwinds pushing the dollar higher are less intuitively appealing than the reasons given for its coming decline:

1. The Federal Reserve printing another trillion dollars (expanding its balance sheet) will devalue the dollar because money supply is expanding faster than the real economy.

2. The Fed is printing money with the intent of devaluing the dollar to make U.S. exports more competitive globally and thereby boost the domestic economy.

Let's examine each point.

1A. If much of the Fed's new money ends up as bank reserves, it is "dead money" and not a factor in the real economy. Fact: money velocity is tanking:

1B. Money is being destroyed by deleveraging and writedowns. This is taking money out of the real economy while the Fed's new money flows to banks.

1C. The purchasing power of the dollar is set by international supply and demand, not the Fed's balance sheet or the domestic money supply.

As for point 2:

2A. Exports are 13% of the economy. A stronger dollar would reduce the cost of oil, helping 100% of the economy, including exporters. Why would the Fed damage the entire economy to boost exports from 13% to 14% of the domestic economy? It makes no sense.

2B. Most U.S. exports are either must-have's (soybeans, grain, etc.) that buyers will buy at any price because they need to feed their people (and recall that agricultural commodities often fluctuate in a wide price band due to supply-demand issues, so if they rise 50% due to a rising dollar, it's no different than price increases due to droughts) or they are products that are counted as exports but largely made with non-U.S. parts.

How much of the iPad is actually made in the U.S.? Basically zero. Is it counted as an export? Yes. How much of a Boeing 787 airliner is actually manufactured in the U.S.? Perhaps a third. Sorting out what is actually made in the U.S. within complex corporate supply chains is not easy, and the results are often misleading.

2C. Many exports are made and sold in other countries by U.S. corporations, and so the sales are booked in the local currency. The dollar could rise or fall by 50% and most of the U.S. corporate supply chain and sales would not be affected because many of the goods and services are sourced and sold in other nations' currencies. The only time the dollar makes an appearance is in the profit-loss statement at home.

Americans tend not to know that up to 75% of U.S. corporations' revenues are generated overseas, in currencies other than the dollar. This may be part of Americans' famously domestic-centric perspective.

2D. Most importantly, the American Empire needs to control and issue the global reserve currency. The Fed is a handmaiden to the Empire; the Fed's claims of independence and its "dual mandate" are useful misdirections.

Some analysts mistakenly believe that Fed policies are aimed at boosting the relatively modest export sector (which we have already seen is a convoluted mess of globally supplied parts, sales in other currencies, etc.) from 13% to 14% of the domestic economy.

Which is easier to export: manufactured goods that require shipping ore and oil halfway around the world, smelting the ore into steel and turning the oil into plastics, laboriously fabricating real products and then shipping the finished manufactured goods to the U.S. where fierce pricing competition strips away much of the premium/profit?

Or electronically printing money and exchanging it for real products, steel, oil, etc.?I think we can safely say that creating money out of thin air and "exporting" that is much easier than actually mining, extracting or manufacturing real goods. This astonishing exchange of conjured money for real goods is the heart of the "exorbitant privilege" that accrues to the issuer of the global reserve currency (U.S. dollar).

It's important to put the Fed's $3 trillion balance sheet in a foreign-exchange (FX) and global perspective:

- The FX market trades $3 trillion a day in currencies.

- Global financial assets are estimated at around $210 trillion. The Fed's balance sheet is 1.5% of global assets.

The key to understanding the dollar and Triffin's Paradox is that as the global reserve currency, the dollar serves both domestic and international markets. Of the two, the more important market is the international one.

To act as the global reserve currency, a currency must be exported in sufficient size to facilitate the gargantuan trade in a $60 trillion global GDP/ $210 trillion global economy. There are only two ways to export enough currency to be remotely useful:

1. Run massive trade deficits, i.e. import goods and export dollars.

2. Loan massive quantities of dollars to nations that will place the dollars in international circulation.

The famous Marshall Plan that helped Western Europe rebuild its economies was just that: a series of large loans of dollars to dollar-starved economies. This was necessary because the U.S. was running trade surpluses in the postwar era and was therefore not exporting dollars.

This leads to a startling but inescapable conclusion: no exporting nation can issue the global reserve currency. That eliminates the European Union, China, Japan, Russia and every other nation running surpluses or modest deficits.

Many commentators are drawing incorrect conclusions from various attempts to bypass the dollar in settling trade accounts. For example, China is setting up direct exchanges where buyers and sellers can exchange their own currencies for renminbi, eliminating the need for intermediary dollars.

This is widely interpreted as the death knell for the dollar. But this misses the entire point of the reserve currency, which is that it must be available in quantity for everyone to use, not just those doing business with the domestic economy of the issuing nation.

Here's a practical example. The $100 bill is "money" everywhere in the world, recognizable as both a medium of exchange for gold, other currencies, goods and services, and as a store of value that is priced transparently (often on the black market). For the Chinese renminbi/yuan to replace the dollar as the global reserve currency, China would need to "export" enough currency to grease trade large and small worldwide, and enough electronic money to act as reserves that support domestic lending in nations holding the reserve currency.

This is yet another poorly understood function of the reserve currency: it acts as foreign exchange reserves, backing up the holder's currency, and as reserves in its central bank that act as collateral for its domestic issuance of credit.

In other words, the U.S. has issued and exported trillions of dollars because this is the necessary grease for global trade, currency stability and issuance of credit by nations holding dollars. The U.S. didn't run massive trade deficits by accident: it needed to "export" more dollars as the volume of global trade expanded.

Issuing credit and loans in dollars wasn't enough, so the U.S. exported dollars in exchange for commodities and goods.

For China to issue the global reserve currency, it would have to decouple the yuan from the U.S. dollar and start running deficits on the order of $500 billion a year.

Many observers think China is preparing to back its currency with gold, and they mistakenly conclude (yet again) this would be the death knell for the dollar. But they haven't thought through how currencies work: their value is ultimately set like everything else, by supply and demand.

In an export-dependent country like China, a gold-backed currency would not be exported in quantity--it wouldn't be "exported" at all, because China "imports" others' currencies in exchange for goods.

Assuming some of the gold-backed currency was exported, it would quickly end up in savings accounts or bank vaults, being a proxy for gold. There will be none available for facilitating trade in the $210 trillion global economy.

This dual nature of money trips up many analysts. Establishing a currency that is "as good as gold" but not exporting it in quantity means it will be hoarded as a store of value and be unavailable to facilitate trade. Money has to act both as a store of value and as a means of exchange.

This is why U.S. $100 bills are carefully stored in plastic in distant entrepots of the world, safeguarded as real money, available as a store of value and as a means of exchange.

Currencies can be exchanged in a Forex (FX) marketplace, but the reserve currency is the "winner take all" in the real world. If you hold out an equivalent sum in various currencies around the world, the trader in the stall will likely choose the $100 bill because he is not sure of the value of the other funny-money in his home currency and he knows he can easily exchange the $100 everywhere.

The other currencies might trade on the FX market at some percentage of the dollar, but in the real world they are effectively worthless because there isn't enough of them available to establish a transparent, truly global market. To do that, a nation has to export monumental quantities of their currency and operate their domestic economy in such a fashion that the currency is recognized as being a store of value.

In a very real sense, every currency is a claim not on the issuing central bank's balance sheet but on the entire economy of the issuing nation.

All this leads to two powerful tailwinds to the value of the dollar. One is simply supply and demand: as the global economy slides into recession, trade volumes decline, and the U.S. deficit shrinks. (It's already $250 billion less than was "exported" in 2006.) That will leave fewer dollars available on the global market.

In the case of the U.S., which exports large quantities of what the world needs (grain, soy beans, etc.) while buying mostly stuff that is falling in price in recession (oil, surplus manufactured goods, etc.), the trade deficit could decline significantly. (It is currently around $40 billion a month.)

And what does a declining trade deficit mean? It means fewer dollars are being exported. The global GDP is about $60 trillion, of which about 25% is the U.S. economy. Into this vast sea of trade, the U.S. "exports" about $500 billion in U.S. dollars via the trade deficit. Put in perspective, it isn't that big compared to the machine it is lubricating.

So what happens when there are fewer dollars being exported? Demand for existing dollars goes up, pushing the "price/cost" of dollars up--basic supply and demand.

The second tailwind is the demand for dollars from those exiting the euro and yen.The abandonment of the euro is already visible in these charts, courtesy of Market Daily Briefing: Peak Euros.

We can anticipate this desire to transfer euros and yen into dollars will only increase as those currencies depreciate. Let's say, just as an example, $5 trillion in euros starts chasing $1 trillion in available U.S. dollars. What will that do to the value of the dollar?

Some ask why those selling euros won't buy Chinese yuan. Where are you going to find $1 trillion in yuan? It isn't even convertible on an open market, and since China is an importer of currency, there isn't 1 trillion yuan floating around the global marketplace to buy even if you wanted to.

Many people scoff when I suggest the dollar could rise 50% (i.e. the DXY dollar index could climb from its current level around 80 to 120) or even 100% (DXY = 160) in the years ahead. I know it's the highest order of sacrilege to even murmur this, but if global demand for dollars picks up, the Fed isn't printing nearly enough to dent the rise in the dollar.

As a lagniappe outrage, consider the domestic fallout from a decline in U.S. stocks and the U.S. economy. The Fed's precious horde of political capital will leak away, and its ability to print more money will be proscribed by political resistance and a loss of faith in the Fed's claimed omnipotence.

Any reduction in Fed printing would only limit the quantity of dollars available to global buyers, further pushing up its price on the open market.

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

Monday, March 25, 2013

It is far too early to be projecting much from Cyprus except a continued erosion of faith in Eurozone banks and leadership, and by default, the euro as a placeholder of purchasing power.

What do we know now that the Cyprus bank crisis has been resolved? What we know--that the resolution follows basic capitalism 101 guidelines of matching risk and loss, unlike the rejected across-the-board tax on all deposits--is dwarfed by what we don't know, for example:

Does the Cyprus "bail-in" set a precedent for much larger Eurozone banking/debt crises?

Though the Cyprus resolution is being held up by some as a model for all future Eurozone bail-outs, is the situation in Cyprus truly applicable to larger economies?

Is the Cyprus crisis a tipping point that marks a sea-change in perceptions of systemic safety and risk?

Though no one can claim with any certainty to have the answers to these questions, we can seek a coherent context for our inquiries. One way to do this is to have a wide-ranging discussion with a well-informed, knowledgeable commentator: in my case, that person is Alasdair Macleod of GoldMoney.com.

Of the many points raised in our discussion, I found these especially relevant to establishing a useful context of the Cyprus crisis:

1. Banks have perfectly legal claims on the money you have voluntarily chosen to deposit. Sovereign nations or multinational organizations like the E.U. may provide insurance on deposits in member banks, but collecting on that promise is not the same as withdrawing your money in a non-crisis situation.

2. Political expediency is often served by changing the rules, either by dictat or by hastily prepared legislation pushed through a legislative body desperate to resolve a crisis in such a way that it retains its own power and autonomy.

3. Cyprus is an offshore financial center designed to attract large deposits from wealthy foreigners (apparently mostly Russians and Britons). In this, it is more like a Caribbean banking center than a large, diverse economy like that of Spain or Italy.

4. The Cyprus banking crisis is fundamentally different from that of Greece. Cyprus is not indebted to foreign banks; its banks are insolvent due to their own mismanagement of loans, assets and risk. The foreign capital is not at risk of a sovereign default; it is at risk of a bank collapse and the seizure of deposits by creditors.

For these two reasons, it may be misleading to project the crisis and resolution in Cyprus onto other quite different financial crises in other quite different economies. The common ground may be a rising fear of capital controls and the search for safe havens that won't implode or change the rules overnight.

5. Loss of faith in one's banks, government and currency may play out in several ways. Those depositing cash in Cypriot banks were very likely hedging the perceived risk of holding that cash in local currencies and local banks.

The sudden emergence of risk in what was perceived to be a safe haven will likely spark interest in non-banking safe havens, for example, precious metals, and what correspondent Mark G. calls the Glass Jar Bank, which he observes is still a popular alternative in Eastern Europe to entrusting one's cash to banks.

6. A lack of alternative investments leads to asset bubbles in whatever asset is perceived as a safe haven. Households in China, for example, save a prodigious amount of their earnings, but this is not just thrift: the social safety net is rudimentary in China and cash is the only safeguard available.

Since the stock market is rightly perceived as a rigged gambling den, the vast majority of Chinese households choose to invest their cash in real estate, as this is about the only alternative to a savings account available to non-Elite households.

Alasdair noted that the Chinese government has encouraged its citizenry to buy gold, and I noted that the government is well aware that the real estate bubble--inflated by housing being the only available place to park savings other than low-yield savings accounts--poses a great hazard to the nation's financial stability.

7. As faith in the Eurozone's banks, leadership and currency erodes, the U.S. dollar will gain value as a mathematical function of the dollar index. Add in the devaluing yen and the dollar will rise significantly against the other major currencies.

8. There is a much larger geopolitical game being played in Cyprus. Despite rumors of Russian participation, the Status Quo remains firmly in place: the Troika managed the banking crisis, Great Britain retains its naval base and the West retains access to any offshore gas/oil that might be recoverable off Cyprus.

What can we conclude about the longer term consequences of the Cyprus banking crisis? In my view, the present confusion is legitimate: it is far too early to be projecting much from Cyprus except a continued erosion of faith in Eurozone banks and leadership, and by default, the euro as a placeholder of purchasing power.

Things are falling apart--that is obvious. But why are they falling apart? The reasons are complex and global. Our economy and society have structural problems that cannot be solved by adding debt to debt. We are becoming poorer, not just from financial over-reach, but from fundamental forces that are not easy to identify or understand. We will cover the five core reasons why things are falling apart:

Complex systems weakened by diminishing returns collapse under their own weight and are replaced by systems that are simpler, faster and affordable. If we cling to the old ways, our system will disintegrate. If we want sustainable prosperity rather than collapse, we must embrace a new model that is Decentralized, Adaptive, Transparent and Accountable (DATA).

We are not powerless. Not accepting responsibility and being powerless are two sides of the same coin: once we accept responsibility, we become powerful.

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